SKY News Summary 3-31-08
Intel announced a joint venture with STMicroelectonics, called Numonyx, which will produce NOR flash memory chips, found in cell phones. Intel currently has 21.8% of this market and STMicroelectronics has 13.9%. The project was announced last May and would have started with a $1.3 billion term loan, but credit markets delayed the deal. The joint venture will start, instead, with $450 million in debt and $585 million in cash. Intel already has a joint venture with Micron Technology which is selling the more-profitable NAND chips (found in cameras and MP3 players) produced in a joint venture with Micron Technology. A spokesman for the company said that “the new venture and Hynix Semiconductor Inc. share ownership of a NAND factory in China, and Numonyx also has arrangements that will allow it to sell chips known as DRAM, for dynamic random access memory. As a result, it can offer customers combinations of chips to handle specific data-storage chores in wireless devices and other applications. We will target areas where we can differentiate ourselves. Our target is not to be a mega-market-share player.”
http://online.wsj.com/article/SB120693158370576281.html?mod=todays_us_marketplace
UBS may, at its April 23 shareholders meeting, ask permission to raise more capital as a cushion against some $70 billion in risky assets still on its books. The capital infusion could be up to 10 billion francs.
http://online.wsj.com/article/SB120692850782375995.html?mod=todays_us_money_and_investing
A panel of experts formally presented, and published in The New England Journal of Medicine articles that called on physicians to sharply curtail their use of two cholesterol drugs, Vytorin and Zetia, marketed by Merck & Co. and Schering-Plough Corp. Instead, it asked doctors to go “back to statins,” the class of cholesterol-lowering drugs that includes Lipitor and Zocor to prevent heart attacks.
http://online.wsj.com/article/SB120689502155475003.html?mod=todays_us_marketplace
The United Nations climate meeting begins today in Bangkok. 163 countries will discuss reducing greenhouse emissions by as much as half by 2050. The European Union proposed reducing emissions in industrialized countries by 20%-40% below 1990 levels by 2020.
http://www.usatoday.com/news/world/environment/2008-03-30-thailand-climate_N.htm?loc=interstitialskip
Discovery Network is introducing a channel in June devoted to all things green. Planet Green is focused on college students and baby boomers who hope to change the environment and will have shows about “ solar-powered racing and bamboo home-building.”
http://www.usatoday.com/life/television/news/2008-03-30-planet-green_N.htm
Duke Energy plans to put solar panels on up to 300,000 customer homes in the Carolinas, according to USA Today. Solar power has grown 45% in the past two years, but still accounts for only 1% of power generation. Providing solar power to customers will allow Duke to meet state renewable energy mandates and avoid expensive substation upgrades while customers are insulated from power outages. The company will have to convince regulators that a solar panel system, while 30% more expensive than a nuclear plant is in its long-term interests. The argument is that electric companies could lose their customers if customers decide to generate their own solar energy by installing their own panels.
http://www.usatoday.com/money/industries/energy/environment/2008-03-30-solar-energy-utilities_N.htm
Duke Energy is joining with automakers to find efficient ways of charging plug-in hybrid cars. “Smart-charging” is essential as California regulators announced last week that automakers are required to put 58,333 plug-in cars on the road from 2012 to 2014. The company and GridPoint, a vendor of smart-charging programs announced that they had charged a vehicle late in the afternoon through off-peak night hours.
http://www.usatoday.com/money/autos/environment/2008-03-30-plug-in-hybrid-electric-cars_N.htm
Sources: Wall Street Journal, Hartford Courant, USA Today, Duke Energy Web site
SKY adds to holdings in Altria Group
Yesterday, we raised our investment weighting in Altria Group to 4% in anticipation of their long awaited spin-off of Philip Morris International (PMI). This new company will be based in Switzerland and will own rights to the Marlboro brand outside of the United States. The domestic Marlboro/cigarette business will continue to operate under the Altria entity and be managed to generate cash flow to investors through dividends and share repurchases.
Both entities have significant cost-cutting opportunities which should drive earnings growth for the foreseeable future. The international business has substantial growth opportunities, particularly in emerging markets where their competition, for the most part, will be large government monopolies.
With the stock spinoff behind these companies, we think they will refocus their efforts on their marketing and operating activities. We expect both stocks to generate solid returns in the months ahead as cost cutting activities lead to earnings growth. And with PMI, we think they can accelerate unit growth which could lead to good earnings-growth-driven returns in the future.
In many accounts, we sold a portion of Procter & Gamble (PG) when cash was needed to settle the trade. We had been over-weighted in PG to take advantage of the synergies from their acquisition of Gillette. With these synergies largely realized, we are cutting back the position to a more typical weighting.
SKY News Summary 3-20-08
Fannie and Freddie received attention again today. In its latest move, the Office of Federal Housing Enterprise Oversight said that the excess capital cushion for the two entities will be reduced by a third. The excess capital requirement for each company will be reduced from 30% to 20%. This move follows the government’s temporary increase in the cap on mortgages from $417,000 to $729,750 and its release of the combined $1.5 trillion cap on their mortgage-investment holdings as of March 1. The Associated Press reported that “OFHEO estimated that the combination of these efforts should allow Fannie and Freddie to purchase or guarantee roughly $2 trillion in mortgages this year.”
http://online.wsj.com/article/SB120593069669648325.html?mod=todays_us_page_one
Russian police raided offices of BP and it’s Russian joint venture TNK-BP seizing documents relating to a criminal case against OAO Sidanko, a company that was merged into TNK-BP in 2003. However, the timing suggests that BP’s Russian shareholders are being strong-armed into selling their shares to OAO Gazprom, the state-run oil giant. A clause that kept shareholders from selling TNK-BP shares expired in January.
ihttp://online.wsj.com/article/SB120595326647349321.html?mod=todays_us_page_one
The FDA will consider expanding its recommended use of Merck’s cervical cancer vaccine, Gardasil. Currently the drug is approved for use in girls ages 9 through 26, but the FDA is considering expanding its recommendation to cover women 27 to 45.
http://online.wsj.com/article/SB120593906245448605.html?mod=todays_us_personal_journal
AIG agreed to pay $13.5 million in a settlement with Pennsylvania’s insurance regulators regarding allegations that the company misreported financial data. The company is settling allegations with individual states ($12.5 million went to nine states and Washington D.C. in January) after its $1.64 billion settlement with the federal government and the state of New York in 2006.
http://www.courant.com/business/hc-natbizdigbrf0318.art2mar18,0,1485706.story
The parent of the Chicago Mercantile Exchange will buy the New York Mercantile Exchange in a $9.4 billion cash-for-stock deal.
http://www.courant.com/business/hc-natbizdigbrf0318.art3mar18,0,1878923.story
NBC Universal, a subsidiary of General Electric, is selling a Hartford TV station (WVIT channel 30), as well as a Miami TV station, to focus its efforts on the top 10 U.S. markets, such as New York and Los Angeles.
http://online.wsj.com/article/SB120598606497351263.html?mod=todays_us_marketplace
The American Public Transportation Association reported that Americans took 10.3 billion trips on buses and trains in 2007, up 2.1% from 2006, and the highest level in 50 years.
http://www.apta.com/media/releases/080310_ridership.cfm
There is a proposal by state lawmakers that would make Connecticut UTC’s largest customer for fuel-cells buses. The state would buy 40 fuel-cell buses a year for four years. Each bus costs $1 million, three times the cost of a normal bus. Another $40 million would go to installing cleaner technology at Bradley International, including fuel cells.
http://www.courant.com/news/opinion/editorials/hc-fuelcell.artmar18,0,448838.story
The first auction for carbon dioxide emissions “allowances” for New England states will be held September 10. The bidding starts at $1.86 per ton. Power plant operators will have until the end of 2011 to acquire enough carbon credits to offset their emissions. Electricity generation contributes 22% of carbon emissions in the state, according to a study from 2001. Transportation accounts for 40% of emissions and 19% is from residential activity.
http://www.courant.com/news/custom/topnews/hc-ctcarbon0318.artmar18,0,906287.story
We should start seeing tax rebates in early May, as they are expected to be mailed by the IRS May 2. They will be sent in numerical order based on the last two digits of the Social Security number. The IRS has an online calculator for eligibility and payment amount at www.irs.gov/app/espc.
http://www.usatoday.com/money/perfi/taxes/2008-03-17-irs_n.htm?loc=interstitialskip
Sources: Hartford Courant, Wall Street Journal, USA Today
SKY News Summary 3-18-08
The Bear Stearns Bail-Out
Bear Stearns, the country’s fifth-largest investment bank, had $395 billion in assets at the end of 2007, $34 billion in cash, but only $11.8 billion in equity capital. That means that the company had a leverage ratio of 33 to 1, and much of this cash was already spoken for. Their margin for error was pretty thin as they began 2008. Last week, customers started pulling their accounts and their cash out of BSC. The company needed to sell assets to cover these outflows but since many assets were mortgage-backed securities, BSC could not find enough buyers. To avoid a classic run on the bank, JPMorgan Chase bought Bear Stearns for $2 a share and guaranted all the BSC debt and credit obligations. Bear Stearns was deemed to be “too inter-connected to fail”.
Today, two other large investment banks reported earnings and both Goldman Sachs and Lehman Brothers had better than expected results. More importantly, management eased fears in the marketplace that these other investment banks lacked sufficient liquidity to support customer demands and outflows. Morgan Stanley reports earnings on Wednesday, and we will get another firm’s perspective on the recent problems in the capital markets.
To put the Bear Stearns failure in perspective, only three U.S. banks failed last year and the last time a major investment bank failed was over five years ago. Currently, the FDIC is monitoring 76 “problem institutions” compared to 1430 banks that were on the FDIC’s watch list in 1991. For the three years around the 1991 recession, 502 banks failed. Back then the problem was poor credit quality, and today, inadequate liquidity toppled bear Stearns.
The problem:
During the housing bubble, when home prices soared, it became difficult for some buyers to purchase homes. Banks and other lenders created new types of mortgages which made mortgages affordable for buyers who normally would not have qualified. Mortgage brokers and banks collected fees for closing the deals, but faced no risk because they sold the mortgages to Wall Street firms which mixed them with other debt and resold them to other investors. (Unlike commercial banks which operate with live-in regulators and are required to disclose troubled loans, investment banks and hedge funds have more liquid portfolios and face less scrutiny). When housing prices dropped, borrowers began to default on their mortgages, and lenders grew wary of making loans, since their ability to package mortgages into mortgage-backed securities declined sharply.(There has been a 20% decline in home construction and sales, and nearly 6% of total home mortgages are now delinquent). Investment banks, such as Bear Stearns, help companies sell their stock and towns sell their bonds to the public. If investment banks don’t provide funding, businesses and municipalities can’t expand and create jobs, or fund construction projects such as bridges and roads. Home mortgages have therefore been harder to attain, and the pace of mergers and acquisitions has also slowed. On the positive side, businesses that would have gone to Wall Street for money through bond or stock sales, may now go to sound local banks for financing.
The government’s solution:
Increase liquidity in the lending market.
The Federal Reserve invoked rarely-used legal authority to lend to non-banks in “unusual and exigent circumstances” and decided to back $30 billion in financing for the sale of Bear Stearns to JPMorgan Chase. The central bank assumed the risk of the collateral put up by Bear Stearns. This action allows the Fed to lend to 20 other securities dealers to get cash liquidity into the securities market. The firms will put up market-grade securities, including some mortgage-backed securities, for overnight loans.
Decrease the discount rate.
The Fed cut the interest rate on direct loans to banks (the discount rate) from 3.5% to 3.25% and extended the length of the loans from 30 days to 90 days.
Cut interest rates.
The Fed cut interest rates. In an 8-2 vote, Fed policymakers cut their target for short-term interest rates to 2.25%, the lowest in more than three years. The discount rate was also further reduced.
The aftermath.
Lowering interest rates will negatively affect yields on money market mutual funds and bank deposits. The value of the dollar will drop, pushing American prices higher, and making the United States investments a cheaper place for foreign investors. There continues to be a net inflow of investment by foreign governments ($75.5 billion in January from China, Russia, and the Middle East), but foreigners are more selective in their investments and may not want to grow their holdings of US dollars. For example, the 10-year Treasury note is a safe investment, but increased interest in this vehicle has pushed yields down to 3.30%. Interest in money market funds has soared, pushing these assets to a record $3.54 trillion in the week ended March 12.
http://www.courant.com/business/hc-ctbanks0318.artmar18,0,3616061.story
http://www.usatoday.com/money/industries/banking/2008-03-17-bear-stearns-investors_N.htmhttp://www.usatoday.com/money/economy/2008-03-17-federal-reserve-crisis_N.htm
http://www.usatoday.com/money/industries/banking/2008-03-17-bear-stearns-bailout_N.htm
Sources: Hartford Courant, Wall Street Journal, USA Today
Mid-Quarter Update
March 11, 2008
“The behavior of past bear markets suggests that this bear market may have its bottom in place by March-April.”
-Mary Ann Bartels, Technical Research Analyst at Merrill Lynch
MID-QUARTER UPDATE
The first quarter of 2008 is quickly coming to a close, and the market’s tug of war continues. In the quarter’s first 47 days, the market has traded up 22 days and down 25 days, as measured by the S&P 500. Certainly, the down days have outweighed the increases as the market has fallen 13.3% year to date. But equally important, this tug of war speaks to the concerns and the uncertainty with which the market is wrestling. High levels of market volatility are common during such periods of uncertainty.
Concerns about subprime mortgages, a credit crunch and a possible recession were the focal points as we began this year, and sure enough, the S&P 500 traded at a twelve month low on January 23rd. But as corporate earnings were released, the market’s tone improved, and the notion of a possible recession was placed on hold. The fact that financial companies dominated the early reporting period in January obviously contributed to this negative start for the year.
However, most companies in your portfolios reported better than expected results almost across the board. On average, our non-financial companies reported results that were up 16.6%* on a year-over-year basis. These results compare to the approximate 12% gain that the S&P 500 non-financial companies delivered. Most of the financial companies did however release disappointing results. But some, like Berkshire Hathaway, reported strong results and have taken advantage of the turmoil to add new businesses and accumulate assets. T. Rowe Price also had very good earnings in the quarter.
But the questions that surfaced in the fourth quarter are still with us today. How bad are the mortgage markets? Have banks taken all the requisite charges? Has the credit crunch gotten worse? And will the contraction in credit lead to a recession? These questions will be answered over the next few months as data on the economy is released. Indeed the probability of a recession has increased given the weak non-farm payrolls numbers that were released on March 7th. But as long as the unemployment level remains low and America keeps working, our economy should keep moving forward. Hence, consumer spending and household activity levels will be the chief focus for the markets in the months ahead.
As March unfolds, we will have more data on the health of the economy and we will hear from the Federal Reserve on how much lower interest rates are likely to go. We also will hear from the investment banks about how their earnings looked for their quarters that ended in February. These results will be closely scrutinized because these companies stand at the heart of the securities markets. Investors will want to hear about the health and strength of their balance sheets, whether or not security write-downs and the charges taken are mostly complete, and if liquidity is coming back into the markets. The answer to these questions will help shape the market’s direction this spring, and then once again, more quarterly earnings will be released in April.
We continue to expect the non-financial companies in your portfolios to report good earnings for this January through March quarter. And later in the year, once the major balance sheet write-downs are behind us and the credit crunch has been addressed, we expect financial stocks to recover as well.
In the meantime, the global economy remains strong, and the large U.S.-based companies with global footprints are doing well and thriving in foreign countries. This revenue growth will be appreciated in due course as the markets begin to settle down. And ultimately, a company’s fundamentals dictate the direction of a company’s stock.
Feel free to give us a call with your questions and comments.
* The 16.6% reflects operating earnings as presented by the companies, but excludes the unusually strong gains at Microsoft and Merck which had unusual comparisons because of Vista and Vioxx respectively.
Alphabet Soup
CLO’s, CDO’s, ABX, Subprime, SIV’s, Conduits, Monolines, Auction-Rate Securities, VIE’s, Credit Default Swaps, CMBX: What would you like to own?
Over the past six months, all of us have been introduced to new terms in the credit markets. Yet these Collateralized Loan Obligations, Collateralized Debt Obligations, and other vehicles are not new instruments. These instruments have evolved over the last decade as financial experts underwrote debt and then divided this debt into smaller pieces to distribute the risks. With credit risks more broadly distributed, banks and investment banks have been able to extend more credit and underwrite even more debt. In consequence, total debt outstanding has grown materially and fueled the strong growth this country has enjoyed over the past fifteen years.
This growth in prosperity has helped many to buy homes and expand operations. BCA Research argues that commercial debt in the economy has grown from about $2.5 trillion in 1989 to almost $16 trillion in 2007. And the Wall Street Journal reported that total debt in the USA as a ratio of gross domestic product increased to 342% in 2007 from 160% in 1975. Suffice it to say that our economy has become more dependent on credit to fuel growth and keep running.
This increase in credit has made all of us more sensitive to any hiccup. So when subprime borrowers began having problems making timely mortgage payments, the securities markets began to examine how overextended the economy might be. With home values then beginning to decline, lenders reduced just how much credit they were willing to extend. Investors pulled in their horns, risk levels were reassessed, and a credit crunch arose as active buyers withdrew from the markets.
In consequence, we have seen greater volatility in the markets. A hiccup in one market impacted other markets. Then other markets backed up, and ultimately some markets, such as the auction rate securities market, practically shut down. Fortunately, American balance sheets hold more cash and are larger and stronger than was the case during the last recession in 2001. Growth in trade has also expanded markets for American companies such that many of our largest companies today earn more than 50% of their revenues from overseas. And the ability to refinance still exists, as witness the state of California just issuing $1.7 billion in general obligation bonds.
So the question is how long will recent market volatility persist, and when might we see an inflection point in the markets. Certainly the market’s tug of war will continue until clearer data is known on the economy’s health and strength. But as long as individuals hold jobs and America keeps working, our economy should keep moving forward. Releases of unemployment and household activity data in the months ahead will provide much guidance for us all. Yet with large cap stocks already trading at the discounted values of the early 1990’s, any hint of improving prospects will likely take the markets meaningfully higher. Stay tuned.